Paul Krugman makes an excellent argument based on behavior economics on the benefits of higher inflation:
Of course, one possibility is to ban the use of COLA clauses in labor contracts. I would be surprised if any economist, let along Prof. Krugman, would advocate that step.
I would add, however, that there's another case for a higher inflation rate -- an argument made most forcefully by Akerlof, Dickens, and Perry (pdf). It goes like this: even in the long run, it's really, really hard to cut nominal wages. Yet when you have very low inflation, getting relative wages right would require that a significant number of workers take wage cuts.Agreed with all of this. Absolutely correct. But Krugman errs when he concludes:
So having a somewhat higher inflation rate would lead to lower unemployment, not just temporarily, but on a sustained basis.That is possible, but not certain. What it could also lead to is higher use of labor contracts with cost of living allowances - that is, labor contracts that are indexed for inflation. Using inflation to cut real wages only works if wages are paid in nominal terms. But if the labor market expects inflation to be high for a significant period of time, then we should expect to see wages paid in real terms, at which point the added inflation gets you nothing.
Of course, one possibility is to ban the use of COLA clauses in labor contracts. I would be surprised if any economist, let along Prof. Krugman, would advocate that step.
Comments
Yes, but with unions an insignificant portion of the workforce, and with unions that have to adapt even their COLAs to the realities of the market, it is a weak one. Better though not to target a fixed inflation rate but one that varies with long term rates, increasing as they decrease to stem leverage and decreasing as they increase to stem excess inflation. Keep everyone guessing.
The comments on Krugman’s article are more enlightening than the article.
Especially liked: “Inflation = stealing, particularly with the current tax law (taxable interest). Only immoral people like inflation. – kuznetsov”
Inflation temps savers into making risky investments and thus is poor social policy.
Inflamatory Keynesian policy at home is dishonest because it takes from the savers and gives to the debtors including the government. All it does is to postpone the time when the money is paid back whilst charging the tax payers interest for the privilidge. How long before the phenomena of getting a free lunch is seen to be untrue and till a policy of taxing what is taken from society (land values, for example) allows the recovery of the country?
TAX TAKINGS NOT MAKINGS!
Anyone ever hear of the stag-flation of the 70’s? Inflation, no growth and no jobs.
The argument regarding inflation is flawed with respect to an open economy that is trade dependent. Inflation would raise costs in such a country that would hurt exports. Unless there is a depreciation of the currency, the real effecrtive exchange rate would appreciate and render exports not competitive unless there is similar rates of inflation in other countrues.